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Developers - keep building but don't run out of money!

In Morris Homes (West Midlands) Ltd v Keay & Another, the Technology and Construction Court (TCC) considered a developer's obligations in an agreement for lease. By clause 3.1 of the agreement, the developer Morris Homes (MH) was required to "as soon as reasonably practicable to commence and thereafter diligently carry out the Works in accordance with the planning permission and all other relevant permissions consents and the documents... in a good and workmanlike manner with good quality materials...".

The dispute concerned the construction of a medical centre in Birmingham and MH's decision to suspend construction work because of the financial crisis. The dispute was referred to arbitration in 2012 and the arbitrator found that MH was in breach of clause 3.1. MH asked the court for permission to appeal against the arbitrator's award, but the TCC judge found that the arbitration award was correct.

The arbitration

Clause 4 of the agreement for lease required the developer to "use all reasonable endeavours to ensure that the Works are completed as soon as reasonably practicable as part of the development unless prevented or delayed by any cause or circumstance not within the reasonable control of the landlord". The arbitrator decided that, together, clauses 3.1 and 4 required MH:

to commence the works as soon as was reasonably practicable;

once the works had been commenced, to carry them out diligently; and

to use all reasonable endeavours to ensure that the works were completed as soon as reasonably practicable - unless prevented or delayed by a cause or circumstance not within its reasonable control.

The arbitrator found that none of these three obligations was subject or subsidiary to the others, the agreement should be construed as a whole, and that effect had to be given to all three of the obligations.

Before the arbitrator, MH had concentrated on the completion obligation under clause 4. It argued that in the summer of 2008, because of the financial crisis, it was faced with risking "commercial suicide" if it continued with the project. It submitted that an obligation to use all reasonable endeavours did not oblige it to take such a risk.

MH argued that if it was found not to be in breach of the completion obligation under clause 4, the obligation to execute the works diligently under clause 3.1 would also be satisfied. In other words, as the arbitrator put it, "if Morris Homes was using reasonable endeavours between mid-2008 and January 2010, it was automatically ensuring that the works were being carried out diligently". However, if this was right, there would have been no need to include an obligation to proceed diligently, because it would automatically have been covered by the obligation to use reasonable endeavours to complete the works.

The arbitrator found that clause 3.1 was independent of clause 4. In stopping work in 2008 and not starting again until January 2010, the arbitrator said MH "was quite clearly in breach of its obligation to carry out the works diligently once they had been started, regardless of whether or not it was also in breach of clause 4."

In summary, the arbitrator decided that MH was in breach of clause 3.1 of the agreement to carry out the works diligently. Further, MH could not avoid liability under clause 3.1 by establishing it had complied with clause 4.

The appeal

MH sought leave to appeal on two key issues: firstly, the proper interpretation of clauses 3.1 and 4 of the agreement for lease; and, secondly, the Keays' losses and causation.

Under section 69(3) of the Arbitration Act 1996, permission to appeal can only be granted if certain conditions are satisfied; for example, the arbitration decision must be wrong; or the question is one of general public importance, and the decision of the arbitrator is at least open to serious doubt. The parties disagreed as to whether these conditions were satisfied and hence the argument as to whether leave to appeal should be given or not.

The contractual interpretation point

There was a measure of common ground between the parties that there was public interest in the court considering the interrelation of "best endeavours" and "diligence" clauses in development and/or construction agreements. However, the Keay brothers - as original claimants, but now the defendants - emphasised that the facts of this case were highly unusual.

From the outset, the parties had known that the project's viability depended on getting a doctor signed up to take an underlease of the medical centre (once the Keays had first been granted a headlease of the completed building) and also on the local Primary Care Trust's agreement to fund the underlease rent. The Keays stressed that these two factors meant the works needed to be completed as soon as possible, and that MH was aware of this. Consequently, being a one-off situation, it was the view of the Keays that any appellate decision would not be of general application. The judge agreed.

What does carry out the works "diligently" mean?

The judge, HHJ David Grant went on to consider the nature of an obligation to carry out works "diligently" in a development or construction contract. Did this obligation relate merely to the manner in which the works are carried out (which usually relates to workmanship and materials), or to the time and/or order in which such works are carried out (which usually relates to programming and sequencing)?

MH argued that if it was not in breach of clause 4, it could not be in breach of clause 3.1. The Keays attacked this submission on the grounds that it would mean MH was entitled to suspend the project indefinitely by reason of its own financial problems. If this could be done without MH being in breach of contract, the Keays would be powerless to do anything about it; no matter how long the suspension of works continued. Consequently, the Keays would remain bound to take a headlease of the completed shell and core whenever it was completed. They would also be bound to fit it out, regardless of whether there was then a doctor willing and able to take an underlease of it.

"... different considerations arise in connection with a 'reasonable endeavours' obligation to complete works ... as compared with a separate obligation to carry out works with diligence ... A party in Morris Homes' position could well comply with a reasonable endeavours obligation to complete works, for instance by taking reasonable endeavours to ensure that it has sufficient capital and other management resources available, but yet be in breach of an obligation to carry out the works diligently, for instance because it failed to carry out the work by using appropriate materials and/or plant in some respect, or by failing to programme the works appropriately."

The judge found that the decision of the arbitrator was not open to serious doubt. It was consistent with the judgment in Ampurius and also in line with other relevant case law. He therefore refused permission to appeal on the contractual interpretation question.

The Keays' losses

The arbitrator stated that the types of losses involved in the case were diminution in value of the headlease, loss of rent under the underlease, additional development costs, and payments required by any incoming undertenant doctor. The arbitrator held that none of these types of loss was too remote. He also found that, as a matter of fact, the Keays did not receive any financial benefit from the delay. They were therefore not required to give credit for a financial benefit which they did not receive.

The essence of MH's appeal was that the arbitrator disregarded the monetary benefit arising to the Keays out of the delay. That is to say, the brothers were able to retain - for longer than originally anticipated - the money that was eventually spent acquiring the building and carrying out the fit-out works.

The judge found that the arbitrator had properly disregarded this issue. It was not actually the Keay brothers who received this financial advantage; instead, it was their father. The case involved a slightly unusual arrangement whereby the two brothers were to take the headlease of the medical centre and act as the landlord of any incoming doctor undertenant. However, they had not - in practical terms - played any part in the development or in the arbitration.

Expenditure by the Keays on the medical centre totalled £1,994,921. The monies were a mixture of gifts from the Keays' parents, a bank loan of £950,000 and money from the Keays' (non-interest bearing) business account. MH argued that because payment for the development was deferred, credit should be given by the Keays at a rate of 6% on £2 million for the period of delay, with a reduction to reflect finance available at 2.59% on £950,000. In the arbitrator's view, this did not reflect reality because the Keays had not received any monetary benefit as a result of the deferred expenditure.

The arbitrator also decided that the Keays would not have required the bank loan of £950,000 to fund the project if the development had not been delayed. Instead, the father would have financed the fitting-out works from his own funds.

The judge found that the arbitrator's decision on the loss point was not obviously wrong; nor was it open to serious doubt. Also, he held that the question of whether damages are to be assessed with or without taking into account a relative monetary benefit - that was obtained by a close associate of a claimant - was not of general public importance. MH had tried to argue that the question needed to be resolved in order to provide greater legal certainty as to how such monetary benefits are to be treated. Permission to appeal was therefore also refused on the loss point.

Commentary

This decision is important for parties entering into construction and related property contracts where diligence and completion obligations are common. Contractual interpretation is, by nature, a complex and difficult exercise. This decision will assist parties in understanding the issues and in trying to predict the courts' approach. However, no two contracts, surrounding circumstances or developments are the same, so this also needs to be factored in when considering what might appear, at first glance, to be a similar situation.

What is clear is that funding problems, or a hostile economic climate, will not excuse a breach of contract. Of course, contracts can be drafted to address and alleviate specific funding risks.